One of the myths of executive compensation is that the most effective way to motivate people to work productively is through individual incentive compensation (Pfeffer, 1998). While most people agree that money cannot buy everything, in organizations there is a widespread belief that money plays a major role in motivating people. Organizations spend a lot of time, effort and money in designing and implementing the right performance management schemes and incentive schemes to motivate their executives. It is accepted as a matter of fact that if only we could measure desirable behaviors and reward individuals commensurate with their results then all our motivational problems would be solved. But what is the truth of this statement? Are monetary rewards and incentive systems a panacea for all motivational issues? While money may definitely help attract and retain talented people, we have reason to believe that monetary incentive schemes may also have some undesirable effects on morale of employees. Kohn (1993) argues that monetary rewards only secure temporary compliance and do not build any long term commitment or lasting behavioral changes in people. According to Meyer (1975) the basis for most of the problems with merit pay plans is that most people think their own performance is above average. Since no plan can give a positive feedback to all persons, it threatens the self-esteem of individuals. People cope with this by demeaning the importance of the job or by derogating the source of the reward. This paper explores the origins of our belief in the motivating power of money and some of the undesirable effects of monetary incentive schemes for executives. We start by trying to understand some of the fundamental assumptions which make us believe that money is a motivator, then we look at some objective evidence on the motivational power of money and finally we focus on some of the dysfunctional effects of relying on money as a motivator.

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Sources of the Belief in the Motivating Power of Money The three pillars on which sustain our belief in the motivating power of money are Adam Smith’s theory of rational self-interest, Herbert Simon’s theory of bounded rationality and Oliver Williamson’s theory of transaction cost economics. Adam Smith described the theory of rational self interest in his book, The Wealth of Nations. in 1776, where he said: “The directors of such [joint stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.” By assuming that the basic nature of employees was to shirk their responsibility, Smith laid the foundation for some external incentive to ensure that the attention of the employees was congruent with that of its owners. Herbert Simon (1945: 67) described the task of decision making as involving three steps (1) the listing of all alternative strategies (2) the determination of the consequences of each strategy (3) the comparative evaluation of these sets of consequences. According to Simon, rationality was “the selection of preferred behavior alternatives in terms of some system of values whereby the consequences of behavior can be evaluated.” He added that – “it is impossible for the behavior of a single isolated individual to reach any high degree of rationality. Individual choice takes place in an environment of “givens” – premises that are accepted by the subject as bases for his choice, and behavior is adaptive only with the limes set by these...

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